Annual Economic Outlook for Cotton

2018 Cotton Economic Outlook
NCC Annual Meeting
Fort Worth, TX

February 9-11, 2018

Good morning.  Thank you for the opportunity to present the National Cotton Council’s economic outlook for U.S. and international cotton markets.  While the presentation will focus on a few highlights, the full report will be available at the end of this session.

2017: Year in Review
Overall, cotton futures were stronger in 2017 relative to competing crops. Oil prices increased to the highest level since mid-2015. The world economy is improving and increased growth is projected for the next two years. World cotton demand is increasing and the latest USDA report projects a 5% increase in consumption in 2017, which is more than double the previous 5-year average. China’s stocks are declining and USDA estimates an 8 million bale decline in 2017.

World cotton area and production bounced back from the low levels observed in 2015 and 2016. World production is projected to increase by almost 14% in the 2017 crop year. However, due to increased production and large carryover stocks, ending stocks outside of China are projected to reach the highest level on record.

U.S. Balance Sheet
To recap the current marketing year, the most recent estimate puts the 2017 harvest just over 21 million bales, up 4 million bales from 2016. The 2017 crop is the largest since the 2006 marketing year and about 6 million bales higher than the recent 5-year average.

U.S. producers planted 12.6 million acres of cotton, an increase of over 25% from the previous spring. Increases were observed in all regions of the cotton belt. The increased acres were primarily the result of higher cotton prices relative to grains and oilseeds.

The estimate for U.S. mill use in 2017 is 3.4 million bales, up 100 thousand bales from 2016. U.S. mills continue to be important and consistent customers of U.S. cotton.

The current marketing year began with cotton stocks at 2.8 million bales. When added to the recent harvest, total supplies for the 2017 marketing year are estimated at 24 million bales. Total supplies will be more than sufficient to satisfy estimated use of 18.4 million bales.

NCC Acreage Survey
With that review in mind, the projections for the 2018 marketing year will begin with the outlook for U.S. production. As in past years, the prospects for the U.S. crop are based on the results of the NCC planting intentions survey with assumptions made for abandonment and yields.

Surveys were distributed on December 15 and responses were collected through mid-January.  Respondents are asked to give their plantings of cotton, corn, soybeans, wheat, and other crops for 2017 and intended acreage for 2018. Once again, it is important to remember that the survey is a snapshot in time based on grower intentions. Changes in markets and weather will cause actual plantings to differ from early-season intentions.

Pre-Planting Market Signals
As always, the survey results should be viewed as a measure of grower intentions prevailing at the time the survey was conducted. During the survey period, the cotton futures prices were stronger relative to competing crops. The price ratios of cotton to corn and cotton to soybeans are more favorable than in 2017.  However, soybeans are expected to provide competition for available acres in 2018, due in part to the lower production costs relative to cotton. While cotton prices have improved relative to other crops, cottonseed prices are at the lowest level since the 2006 marketing year, thus increasing the net costs of ginning.

It is important to call attention to the ratios because past experience has shown that these ratios are reliable indicators of changes in cotton acreage. Historical data over the past 10 years shows a clear relationship between the price ratios and changes in cotton acreage.  A review of the Council’s survey will begin with a look at the Southeast.

2018 Southeast Acreage
In the Southeast, survey results indicate a 2.3% increase in the region’s upland area to 2.6 million acres. All six states show an increase in acreage. In Alabama, the survey responses indicate 0.8% more cotton acreage and less wheat, soybeans, and ‘other crops’. In Florida, respondents indicated more cotton and soybeans and less ‘other crops’, likely peanuts.

In Georgia, cotton acreage is expected to increase by 0.6%. Georgia growers expect to plant less soybeans and more corn and ‘other crops’, likely peanuts. In North Carolina, an 8.2% increase is expected as acreage moves away from soybeans.

In South Carolina, acreage is expected to increase by 3.4%. South Carolina growers expect to plant less corn and wheat and more soybeans and ‘other crops’. Cotton acreage is expected to increase by 3.1% in Virginia. Virginia growers intend to plant more corn and soybeans and less wheat and ‘other crops’.

2018 Mid-South Acreage
In the Mid-South, growers have demonstrated their ability to adjust acreage based on market signals, in particular, the relative prices and potential returns of competing crops. Mid-South growers intend to plant 1.9 million acres, which is a slight decrease from the previous year. Across the region, Louisiana and Mississippi intend to decrease cotton acreage and Arkansas, Missouri, and Tennessee expect to increase acreage.

The largest decline was reported in Mississippi with 5.5% less cotton acreage in 2018. Mississippi respondents expect to increase acreage of all other crops as less cotton acreage is planted. In Tennessee, cotton acreage is expected to increase slightly as land shifts away from corn and wheat. Missouri growers expect to increase cotton acres by 3.8% and plant less corn and soybeans. In Louisiana, respondents intend to plant 2.6% less cotton acreage, more soybeans, and less of all other crops. All states in the Mid-South except Missouri intend to plant more soybeans in 2018.

2018 Southwest Acreage
Growers in the Southwest intend to plant 8 million acres of cotton, an increase of 5.7%. Increases in cotton area are expected in each of the three states. In Kansas, producers intend to plant 55% more cotton acres, along with more wheat and ‘other crops’, likely sorghum.

In Oklahoma, a 21% increase in cotton acreage is expected as wheat acreage declines. Overall, Texas acreage is expected to increase by 3.7%. In south Texas, respondents indicate a 0.3% increase in cotton acreage. South Texas growers intend to plant less corn and more wheat, soybeans, and ‘other crops’. Respondents from the Blacklands indicate an increase of 8.6% in cotton acreage, a decrease in wheat and corn acreage, and an increase in ‘other crops’. In West Texas, respondents indicated a 4.0% increase in cotton acreage, an increase in wheat acreage, and a decrease in corn and ‘other crops’.

2018 West Acreage
With intentions of 293 thousand acres, producers in the West are expecting to plant 6.8% less acres of upland cotton. Cotton acreage is expected to decline in Arizona and California and increase in New Mexico. The survey results for Arizona suggest a shift from upland cotton to ELS cotton, corn, and ‘other crops’. In California, growers intend to plant more wheat and corn.

2018 ELS Acreage
The survey indicates that growers intend to plant slightly more ELS cotton in 2018. Arizona growers are expecting to plant 31.6% more ELS cotton. Overall, U.S. cotton growers intend to plant 254 thousand acres in 2018.

U.S. Cotton Production
Summing across the 4 regions gives intended 2018 upland cotton area of 12.8 million acres, 3.8% above 2017. The survey indicates that growers intend to plant slightly more ELS cotton in 2018. Arizona growers are expecting to plant 31.6% more ELS cotton.

Overall, U.S. cotton growers intend to plant 254 thousand acres in 2018. Summing together the upland and ELS cotton intentions shows U.S. all-cotton plantings in 2018 of 13.1 million acres, 3.7% higher than in 2017.

Given the economic climate, it is important to discuss the factors affecting cotton acreage in 2018. Based on the current price of cotton and cottonseed, total revenue is expected to fall short of total costs. However, in the Southwest, cotton is still the better alternative and a significant increase in acreage is expected for Oklahoma and Kansas.

Low wheat prices along with above-average yields in 2017 will likely encourage more cotton acreage in the Southwest in 2018. Kansas had a tremendous increase in acreage in 2017 and another large increase is expected for 2018. Kansas growers have greatly benefited from the availability of Dicamba and 2,4-D tolerant varieties.

In the Southeast and Mid-South, cotton continues to be a good alternative, but some growers may expect higher returns from other crops in 2018. In the West, expected water availability may be influencing cotton acreage decisions.

Planted acreage is just one of the factors that will determine supplies of cotton and cottonseed. Ultimately, weather, insect pressures, and agronomic conditions play a significant role in determining crop size. The NCC economic outlook does not attempt to forecast weather patterns and the standard convention is to assume yields in line with recent trends and abandonment consistent with historical 5-year averages.

However, due to the dry conditions that currently persist across the cotton belt and the anticipation of abnormally dry conditions throughout the spring, the abandonment estimates for Texas and Oklahoma are slightly higher than the recent 5-year average. As always, it is important to remember the volatility around projected production given the uncertainty of weather patterns.

With abandonment set at approximately 15% for the U.S., Cotton Belt harvested area totals 11.1 million acres (Figure 56). Using an average 2018 U.S. yield of 842 pounds generates a cotton crop of 19.4 million bales, with 18.7 million bales of upland and 744 thousand bales of ELS. The projected crop represents a 1.8 million bale decrease from the latest 2017 estimate. If drought conditions continue across the cotton belt, further reductions in the 2018 production estimate may be necessary.

Drought Monitor
While the drought monitor shows abnormally dry conditions across the Cotton Belt, the situation in the Southwest is of particular concern. Very little rain or snow has fallen in West Texas or Oklahoma in the past 90 days. The lack of precipitation in Texas is reaching historic levels. According to the National Weather Service, February 7 was the 117th consecutive day without measurable precipitation in Amarillo, which is higher than the previous record of 75 days. In Lubbock, February 7 was the 91st consecutive day without measurable precipitation, which is just below the 98-day record.

U.S. Balance Sheet
Returning to the U.S. balance sheet, we can turn our attention to the prospects for U.S. cotton demand. First, let’s look at cotton consumed by U.S. mills.  A slight increase in consumption by the domestic textile industry is projected in the 2018 marketing year. U.S. mill use is estimated to grow by 60 thousand bales in 2018.  U.S. exports are projected to be 14.3 million bales for 2018. When exports are added to U.S. mill use, total offtake is 17.7 million bales. Recall that the U.S. crop is estimated at 19.4 million bales, thus leading to an increase in ending stocks of 1.5 million bales.

U.S. Exports
U.S. exports are estimated to reach 15.0 million bales in the 2017 marketing year, which is higher than the USDA estimate released earlier this week.  U.S. export sales have been very strong with early sales surpassing previous crop years. The heavily discounted low micronaire Texas cotton appears to have boosted export sales.

If the current sales pace continues, the strong demand for U.S. cotton could push U.S. export commitments even higher. However, shipments have been lagging behind sales during the first half of the marketing year. As of Feb. 1, sales had reached 13.0 million bales, but only 5.2 million bales had been shipped, which is the second-lowest shipment percentage in the last decade (at this point in the marketing year).

While several factors led to shipping delays earlier in the marketing year, trucking shortages, along with increased trucking costs, are currently the main issue impacting cotton shipments.

In the USDA report released on February 8, USDA lowered U.S. exports by 300,000 bales to 14.5 million bales in part due to the current level of shipments and the weekly shipments needed for the remainder of the marketing year.

The shipment pace has increased over the past few weeks, which is not surprising since the pace during the second half of the marketing year is generally higher as harvest and ginning is completed. With twenty-six weeks remaining in marketing year, an average of about 375,000 bales will need to be shipped each week to reach the 15.0 bale estimate. In the latest export report, shipments reached almost 470,000 bales, which is the highest level for the marketing year.

USDA is expecting a slower sales pace in the second half of the marketing year due to a potential increase in competition from Australia (due to an early harvest) and lower exports to Mexico (due to increased production).

The current U.S. export estimate breaks down into 14.4 million bales of upland cotton and 650 thousand bales of ELS cotton. The U.S. will remain the largest exporter of cotton with a market share of 39.1% as compared to 40.1% in 2016. World trade is projected to be higher in the 2017 marketing year, but increased competition from other major exporting countries has led to a decline in the U.S. market share.

China’s Balance Sheet
Demand growth in major cotton consuming countries is expected to continue in 2018, with the largest increase of 1.8 million bales in China. USDA had projected a slight increase in China cotton imports for the 2017 crop year, but lowered the estimate in January 2018 due to a significant increase in China’s expected cotton production in 2017. USDA currently projecting a large increase in China’s production in 2017 due to increased acreage and yields.

China reduced acreage and production from 2011 through 2016 as cotton shifted out of the lower-yielding areas and into Xinjiang. China increased acreage in 2017 following two years with very low cotton acreage. However, the 2017 level of 8.2 million acres is still 41% below the 2007-2012 average. Looking ahead, China’s cotton acreage is expected to remain fairly stable. Large increases in acreage are not expected in Xinjiang due to limited water availability.

Although China’s consumption has increased over the past three years, domestic use remains well below historical highs. Growth in world cotton demand remains a concern as competition from lower priced manmade fibers continues to weigh on the market. While internal cotton prices are still strong relative to polyester prices, polyester prices increased in 2017 and are currently at the highest level since 2014. China’s new environmentally-friendly policies could impact manmade fiber production and use in 2018.

Increased sales of Chinese reserve stocks have led to more domestic spinning of cotton. The gap between domestic and international cotton prices has narrowed and is expected to reduce yarn imports as domestic yarn becomes more price competitive. Vietnam was the top supplier of cotton yarn to China in 2017, followed by India and Pakistan.

China is expected to continue to limit import quotas to the required WTO minimum tariff rate quota (TRQ) of 4.1 million bales for the 2017 crop year as China continues to work through reserve stocks. Various sources have reported the possibility of additional imports to rotate the reserve stocks. However, no official announcement has been made.

For 2018, a slight increase in China’s acreage is expected.  Production is estimated at 26 million bales, which is 23% below China’s average production from 2007 to 2012. China’s consumption is expected to increase by about 4% in 2018 to 42 million bales. The adjustments in China’s supply and demand, including the success of the reserve auctions, will allow a reduction in stocks.

China Ending Stocks
China will begin the next round of reserve auctions on March 6. China sold almost 15 million bales from the reserves in 2017 and another successful auction series is anticipated for 2018. China plans to gradually reduce stocks each year until the reserves reach what they consider a ‘reasonable level’. As we look at historical stock levels in China, average ending stocks were about 20 million bales prior to the build-up of stocks in 2011.

A successful auction series in 2018 could easily put China in a position to become a larger cotton importer again. In 2018, an additional 10.0 million bale reduction in total stocks is expected, which would reduce stocks to 29 million bales.

China Cotton Balance Sheet
The gap between China’s cotton consumption and production is currently around 15 million bales, with the gap currently filled by reserve sales and imports. Once the reserves are further reduced, additional imports will be needed to fill the gap.

India recently announced a change to the Minimum Support Price (MSP) policy for the 2018 crop year.  India plans to set the MSP price equal to 150% of the cost of production which is significantly higher than the current level. An increase in the MSP price could have implications for both domestic and international cotton trade. The MSP acts as a price floor which could reduce the competitiveness of Indian cotton and lower exports. Higher internal prices could also lead to increased imports as spinners consider lower cost options.

World Balance Sheet
For the world balance sheet, global production of 119.3 million bales is lower than in 2017. World mill use is projected to increase to 124.8 million bales, which is the highest level in more than a decade. Cotton consumption has continued to increase for the past four years.

World cotton stocks decline by 5.4 million bales in the 2018 balance sheet. While projections of global consumption exceeding production would normally be supportive of prices, the implications for the coming year may not be as clear cut. The decline in global stocks is due to reduced inventories in China. Stocks outside of China – an important barometer of price conditions – are projected to increase by 4.6 million bales.

USDA’s latest estimates show a 5% increase in world mill use in 2017 and a 6.7% increase in China. Supported by continued growth in China, world consumption is projected to increase by 3.3% in 2018. The growth is leading to additional cotton import demand in key countries such as Vietnam and Bangladesh.

World Cotton Trade
As the net effects of the trade adjustments are aggregated together, world cotton trade for 2018 is estimated at 39.0 million bales, up 638 thousand bales from 2017. The United States is expected to capture approximately 37.0% of world trade by exporting 14.3 million bales in the upcoming year. Increased competition from other cotton-producing countries is expected to reduce both U.S. exports and U.S. market share in 2018. However, it is important to note that the U.S. projections are highly contingent on the global cotton market.

Cotton Prices
While the Council’s economic outlook does not attempt to project cotton prices, it is important to review some of the factors shaping the current price situation. Cotton prices have maintained a stronger appearance since October 2017 despite the projected increase in world production and resulting increase in ending stocks.

While the current supply and demand fundamentals would generally translate into downward pressure on prices, this has not been the case for the last few months. The strong demand for U.S. exports, weaker U.S. dollar, heavy speculative buying, and large mill fixations are supporting prices. The current price environment could also suggest that stocks may be smaller than the current estimates and additional revisions to the world balance sheet may be necessary. For the coming year, projections of record ending stocks outside of China could put pressure on prices.

For the past four years, U.S. cotton producers have struggled with low cotton prices, high production costs, and the resulting financial hardships. While the survey results suggest a slight increase in cotton acreage, the increase is largely the result of weaker prices of competing crops.

Although cotton prices have improved slightly compared to other crops, cottonseed prices have dropped significantly, thus leading to an increase in net ginning costs. Many producers will continue to face difficult economic conditions in 2018. Production costs remain high, and unless producers have good yields, current prices may not be enough to cover all production expenses.

Final Thoughts
Based on the underlying assumptions and resulting cotton balance sheet, the increased stocks outside of China may contribute to a more bearish tone for cotton prices in 2018. The U.S. export pace will be a key factor to monitor during the remainder of the 2017 marketing year.

As with any projections, there are always uncertainties and assumptions that can dramatically change the balance sheet. China’s stocks and import policy, as well as India’s price support policies, provide significant uncertainty for global markets.

2018 is shaping up to be an interesting year for the U.S. cotton industry with an improving world economy and growth in cotton demand. We hope this outlook can provide insights to help the industry address those challenges.

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